Blowoff Top In Leader Should Strike Fear In You

When a market leader does an about turn, it’s time to pay really close attention to the sentiment changing in the market.

On Friday, February 16th that’s precisely what happened with SMCI, a market leader that had run up from $55 per share in September 2022 to over $1,000 per share by February 2024.

The run up of approximately 20x in share price was astronomical, though some smart investors did even better by loading up on LEAPS back in 2022 and saw even higher gains.

As the morning of Friday 16th began, SMCI offered few clues as to what was about to happen. It opened at around $1,045 per share and rose to $1,077 per share. Just another day of massive gains on the cards, it seemed.

But then a tectonic shift took place. SMCI peaked, and did a U-turn and started to plunge. Within 40 minutes of the open, SMCI has fallen off a cliff to $870 per share, a decline of over $200 per share in a little over a half hour.

Now if you’re wondering whether it’s significant, it is. This is a move to be respected, and now it’s time to put your helmets on and brace for impact across the market more generally.

Key Points

• Stock market leader, SMCI rose on Feb 16th within the first few minutes of trading before plunging $200 within a half hour of the open.
• One analyst suggests the best play now is to short stock and buy calls to profit from IV spikes.
• A further possibility is to sell calls against stocks or buy puts against shareholdings to mitigate risk.

How To Play The Market Now

When Cem Karsan came out and said a window of weakness is opening in February, he expanded to comment that March is one of the largest options expirations on the calendar and so a fat tail of risk exists. If the market starts to fall, it can unhinge quickly and decline dramatically, much like it did in 2020. If it can ride through the window of weakness period, expect a further ramp up in prices, however.

On the first day of the window opening, the S&P 500 tumbled 0.40% in the first hour of trading and the market leader experienced a clear blow off top. That’s the market sending a shot across the bow.

If you’re heavily exposed to stocks, now is the time to re-evaluate risk carefully. Imagine each position dropping by 20% in your portfolio, how would you handle those losses?

One approach to mitigating risk is to sell calls against those stock holdings and mitigate risk to some extent. Selling longer dated calls is usually the smart play because it means lowering cost basis more than can be achieved with shorter duration calls.

Buying put options is yet another approach to better managing risk. Of course when you want to buy puts they tend to be expensive so selling in-the-money calls is often a way to achieve a greater degree of protection than an out-of-the-money call while enjoying more risk protection as is associated with a put option.

Karsan himself has recommended the play to short stocks and buy long calls. If implied volatility rises because the market burns upwards, then the IV spikes will offset much of the losses from the short positions but a downward movement would lead to more gains from shorts than losses from calls.

Regardless of how you play the market now, the tenor of it has changed when the market leader decided to do a U-turn to such a dramatic extent, and that shouldn’t be ignored.